General Electric (GE) reports before the bell on Friday morning, July 19th, with analyst consensus expecting $0.35 in earnings per share (EPS) on $35.55 billion in revenue, for expected year-over-year declines of 8% and 3%, respectively.
2013, 2014 and 2015 consensus EPS estimates have remained stable over the 90 days, which is a plus although there has been erosion in the 2013 and 2014 EPS estimates over the last 12 months. Revenue estimates have eroded too after the last 12 months.
In q1 13, GE reported order growth of +3%, although Industrial revenues fell 6% and operating profit fell 11% mainly on Water and Power division weakness.
There are a number of elements to GE that the average investor might not be conscious of given the developments around the 2008 Financial Crisis (and recession) which might have a long-lasting impact on GE:
1) The business model of wrapping industrial, aerospace, energy and other operating businesses around a "finance" company, which in this case is GE Capital, is very much out of fashion and impolitic today, but that is what GE is left with after the 1980's and 1990's. Most pundits refer to this model as a "finance company in drag", which was very prevalent throughout the industrial, agriculture, and auto businesses in the 1980's and 1990's;
2) GE Capital is still roughly 1/3rd of GE's revenues and operating income and is now akin to the wayward stepchild the family doesn't talk about. Recently the Fed and the bank regulators labeled GE Capital a SIFI (systemically-important financial institution), and after reading some of the recent speeches, it sounds like GE Capital management spends almost as much time talking with the banking regulators and dealing with regulatory issues as they do managing the business. Management has taken every opportunity to actively "talk down" GE Capital and its importance.
3) Because of #1, much of the 1980's and 1990's growth was built on "leverage" or debt leverage to be specific, and again, leverage is out of favor, which means companies are looking for organic growth, and strategic acquisitions, which is part and parcel to GE's "portfolio management" strategy, but just on a much smaller scale, since GE Capital cannot be the medium to finance or drive growth going forward;
So where does that leave us today ?
GE (the stock) peaked at $60 per share in September of 2000, and today trades at just a little over 1/3rd of that all-time high peak, despite the SP 500 having moved to an all-time high in April, 2013.
The stock has massively underperformed the market in the last 13 years, having been faced with horrific events like 9/11 (planes powered by GE engines, hitting GE-insured buildings), etc., not to mention a flat stock market, that treated the old mega-cap growth leaders with p.e compression and much lower valuations.
However, the flip side of this is that GE today is a far better value than it ever was in the tail-end of the 1990's albeit with a lower growth profile.
With the future of the business being the Industrial segment, we track cash-flow growth for Industrials on our internal spreadsheet, and since the market bottom in March '09, GE Industrial cash-flow growth since that time is a -2% per year over the last 4 years, (yes, you read that right). If we track back all the way to 2003, Industrial cash-flow growth is just 5% per year over a 10-year time frame.
Jeff Immelt, who is probably not as bad of a CEO as his stock price performance suggests, has not re-made the Industrial or non-finance portfolio as the business model requires, and even with the aerospace business really doing well.
The earnings and cash-flow generation for the Industrial segment is not yet "GE-like" and it is hard to say what is a tranformative acquisition or strategy for the company.
The Industrial's segment free-cash-flow growth is formidable though as free-cash-flow of $12 billion (4qtr trailing as of 3/31/13) has grown 32% off the March '09 lows, and 37% off the 2003 lows, so most of the free-cash-flow GE is generating (at least by the SEC fiings, which again makes for a tough compare given that analysts don't evaluate finance companies based on "cash-flow" but rather capital) comes from Industrials.
GE Consolidated and GE Industrial Cash-flow History
* Source internal spreadsheet
* dollar amounts in billions
* TTM is trailing 12-month
* CFO is cash-from operating activities
* FCF is free-cash-flow (CFO less capex)
While this is a busy table, studying cash-flow can tell an investor volumes about a company. Note how free-cash-flow is about 50% of CFO at Consolidated GE, but a much higher percentage at Industrial. GE Industrial cash-flow and free-cash-flow just started growing rapidly the last 6 - 9 months, so we hope it continues.
The real wild-card is how much capital GE can milk from GE Capital and distribute to shareholders.
GE's valuation today is somewhat attractive, with less than stellar growth. At $23.50 per share, GE is trading at 14(x) the current 2013 EPS estimate of $1.66 and 13(x) the 2014 EPS estimate of $1.82 for expected y/y growth of 9% and 9% respectively. (I'd say on a p.e basis, GE is pretty fairly valued.)
GE's cash-flow valuation is what interests me, at 8(x) price-to-cash-flow with 9% earnings growth and 12% cash-flow growth since '09, I do think GE can earn - in a low-growth, steady-state economy - at least $3 - $3.50 on operating cash-flow per share (OCFPS), which would put intrinsic value in the low $30's.
Morningstar currently places an intrinsic value on GE of $27 per share.
Ironically, despite the de-emphasis on GE Capital, it has been the improvement in GE Capital, both from a credit and business perspective, that has allowed GE to pay a better dividend and is the source of the better cash-flow growth.
If you look at the 13-year history of GE operationally, and in a period where the Sp 500 was flat over this long-time frame, it is clear consolidated GE is a low-to-mid-single-digit organic grower.
Year-over-year Revenue and EPS Growth
|Avg ex '00 and '09||2%||7%|
* Source - internal spreadsheet
GE's dividend yield is currently 3.5%, and is one of the most compelling aspects to owning the shares.
We didn't put up the table, but GE is currently distributing just 50% - 75% of its free-cash-flow into the dividend and share repurchase program. There is more capital that can be returned to shareholders, should GE want to, although they did announce a $10 billion share repo plan in q1 13.
So what catalyzes GE stock ?
1) In mid-June after the announcement was leaked to the Wall Street Journal, GE named Keith Sherrin as the new CEO of GE Capital effective July 1, replacing Mike Neal, who had turned 60 this year. Would GE spin-off GE Capital and try and get real value in a better market for finance and bank stocks ? Given the valuations in the bank sector I doubt it, plus GE Capital is still contributing to GE consolidated, despite what management says. Then again, if they are talking down the business, why not spin it off ? GE Capital is 2/3rd's commercial lending - if that segment starts to do well, does GE hide the numbers or play down the contribution ? Either embrace GE Capital or get rid of it, since management is talking out of both sides of its mouth;
2) A return to global growth would benefit GE, given the size of non-US operations;
3) Let's face it, if GE announced that Jeff Immelt was being replaced, it could be worth 10% to the upside on the stock price. I think it only a matter of time. To be CEO from early 2001, until today certainly wasn't easy and he did what he could, but it is hard to see what energizes the Industrials segment and shakes GE out of this slump. TO be clear, Immelt is probably a decent CEO, but he followed an iconic CEO and was dealt a tough hand of cards.
4) The Lufkin acquisition seems to be a clear bet on oil & gas, and one broker even said that oil & gas is likely to be the largest Industrial segment over the next few years;
We are long the shares of GE for clients, as a somewhat defensive, higher-yielding name for clients, which ironically, despite the dividend yield, didn't really participate in the "dividend trade". The stock is up 12% year-to-date (not including the dividend) so we are getting what we want from it from a portfolio holding standpoint, expecting that at some point the stock gets a catalyst from GE Capital, a management change or better global growth abroad.
5) Technically, the stock is improving, but continues to lag the broader market.
Studying GE can be like the three blind men and the elephant. It is a huge company with a lot of moving parts, and while disclosure and transparency is quite good, investors are beginning to fret about the stock price.
Can GE Industrials generate better growth, what is the ultimate plan for GE Capital, and will a management shake-up benefit the stock?
Inquiring minds want to know.